What Are Investors to Make of PepsiCo's Share Buybacks?

PepsiCo is one of the best-known stocks in the consumer space, with the company holding a large number of well-known brands, including its flagship Pepsi and Gatorade beverages, in addition to food products like Frito-Lay and Quaker Oats. PepsiCo is appreciated by investors for its long track record of steady growth and reliable dividend payments.

Recently, PepsiCo has accelerated its share buyback program in an effort to return even more cash to shareholders. PepsiCo is spending billions of dollars this year to buy back shares. It's reasonable to question this strategy, since PepsiCo's free cash flow is actually down over the first half of the year, as compared to the same period last year.

Is PepsiCo spending too much on share buybacks?Earlier this year, PepsiCo announced it would significantly increase its capital allocation programs after providing first-quarter results. At the time, management revealed it would return approximately $8.7 billion to shareholders through a combination of dividends and share repurchases in 2014. Of this, PepsiCo planned to utilize $3.7 billion for dividend payments and $5 billion for share repurchases. In all, this would represent a 35% increase in total cash returns to shareholders versus the prior year.

In terms of just share buybacks, PepsiCo's $5 billion in planned repurchases this year would represent a 60% increase from the $3 billion in buybacks conducted last year.

PepsiCo generated $1.7 billion of free cash flow over the first six months of 2014. In the same period, PepsiCo bought back $2.1 billion of its own shares. Its share repurchases more than doubled from the same six months last year. Meanwhile, PepsiCo expects to generate $7 billion in free cash flow this year, which would fall short of its total cash returns to shareholders.

While that might normally give some investors cause for concern that perhaps PepsiCo was getting too aggressive with its capital allocation, it's worth noting that PepsiCo is a very strong company. PepsiCo's diluted earnings per share were up 5.5% through the first half of the year. It's seeing especially strong results in the emerging markets, where growth is far superior to growth in more mature economies.

For example, PepsiCo realized organic revenue growth of 8% last quarter in developing and emerging markets. This was double the growth rate of PepsiCo Americas Foods. Meanwhile, PepsiCo Americas Beverages increased organic revenue by just 1%, so it's clear that the emerging markets will be a major growth avenue to fuel PepsiCo's shareholder rewards programs going forward.

PepsiCo expects to generate enough cash to keep buying back stock at such an aggressive pace without putting its financial position in danger. Management expects 8% earnings growth this year. Of course, some of this has to do with PepsiCo's share buybacks. PepsiCo's Chief Financial Officer stated during the company's most recent conference call with analysts that PepsiCo's diluted share count declined by 2% last quarter. Plus, PepsiCo is in the process of shaving $1 billion off its expenses this year as part of a companywide productivity program.

The Foolish bottom linePepsiCo holds a diversified business across several different product categories, which helps provide more consistent cash flow. For that matter, PepsiCo's sales are almost evenly split between food and beverages. And since PepsiCo's products are foods and beverages, it generates fairly reliable cash flow. Thanks to projected cost savings and an outlook for solid organic growth, fueled mostly by the emerging markets, PepsiCo is confident in returning a huge amount of cash flow to shareholders through share buybacks.

It's reasonable to be concerned about PepsiCo's capital allocation methods, since dividends and share buybacks this year are likely to exceed free cash flow. If this continues, PepsiCo may need to curtail its share buybacks somewhat in future quarter. That's why investors should continue to monitor the company's financial performance. For the time being, however, there doesn't seem to be an immediate reason for alarm, because PepsiCo holds a premier brand and highly profitable company. That's why, for the time being, PepsiCo's share repurchase plans make sense.

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